Financier Worldwide Annual Review: Transfer Pricing 2016 – United States
Excerpt taken from the report.
Q. What do you consider to be the most significant transfer pricing changes or developments to have taken place in your region over the past 12 months or so?
Armitage: The most startling transfer pricing development does not involve transfer pricing, at least technically, and it is not in the US. It is the European Commission’s case against Apple under the European Union’s state aid law. Apple secured tax rulings from Ireland many years ago that the European Commission asserts are illegal state aid, so Apple should pay more than $14bn in past taxes and interest; the US Treasury has defended Apple. US companies are watching this case closely. In addition, US transfer pricing litigation, in particular, against Microsoft and Coca-Cola Inc., has grabbed taxpayers’ attention. On a positive note, the US government and India broke their stalemate over competent authority disputes and advanced pricing rulings.
Q. In your opinion, do companies pay enough attention to the challenges and complexities of maintaining compliant transfer pricing polices?
Armitage: The largest multinationals are keenly focused on establishing strong transfer pricing policies and ensuring adequate documentation. Smaller companies present a more mixed picture. Many of these companies have not been challenged in audits on transfer pricing so they still view transfer pricing work as ‘nice to have’ rather than essential. Many of these smaller companies will be required to prepare country-by-country reports for 2016 and that may spark companies into paying closer attention to transfer pricing.
Q. To what extent have the tax authorities in your region placed greater importance on the issue of transfer pricing in recent years, and increased their monitoring and enforcement activities?
Armitage: Tax authorities in the US, Canada and Mexico have aggressively increased their focus on transfer pricing, but this has been a decade-long development, not just a change initiated over the past few years. The US government is making a strong effort to focus its limited resources on the most important cases, matters with large amounts of tax at stake or important legal issues. US companies are well aware that other countries frequently focus their audit attention on US multinationals, both because US companies are often large and because of a perception that US multinationals engage in more tax planning than companies headquartered elsewhere.
Q. How should companies respond if they become the subject of a tax audit or investigation? What documentation needs to be made available in this event?
Armitage: Proper preparation for an audit begins long before tax examiners begin an audit. Most attention now is focused on country-by-country reporting; taxpayers need to make sure they can gather the information and explain any results that seem anomalous. And, the master file that most companies will be required to prepare is both a burden and an opportunity: taxpayers should view the master file as a chance to put forward an informed explanation of how the company operates and where value is created. The master file and country-by-country reports should inform and reinforce each other. Many US taxpayers face a further challenge in complying with new regulations under Section 385 that relate to loans from foreign related parties to US persons. These regulations will require taxpayers to more closely understand and document these loans. Finally, company tax professionals need to make sure their CFOs, and even their CEOs, understand the new world of transparency for international tax reporting, because of the high risk of publicity about tax matters.
Q. What kinds of challenges arise in calculating appropriate transfer prices, both for tangible and intangible assets? How crucial is it to have consistent supporting documentation?
Armitage: The biggest challenge for taxpayers is to understand – really, truly understand – the value chain for a company, and then to explain that value chain. How does the company make its money? What is the competitive advantage for the taxpayer? Under BEPS, a transfer pricing inquiry does not look at the functions, assets and risks of a single subsidiary, but extends to the value chain of the global company. Taxpayers need to be ready to explain the entire company’s operations. Furthermore, neither taxpayers nor tax authorities fully appreciate the difficulty of taking a transfer pricing method and then constructing a price list. Taxpayers do not price goods and services using a ‘method’. The taxpayer must project future volumes, costs, selling prices and arm’s-length margins, and then prepare a price list. And a price list for 2017 uses data from 2015 and 2016, while the world is constantly changing. The best-prepared taxpayers have process maps to explain how they take company data, prepare a price list and then document that the results are arm’s-length.
Q. Have you seen an increase in transfer pricing disputes between companies and tax authorities in your region?
Armitage: There is a heightened sensitivity to transfer pricing, so more US audits are including an international examiner who raises questions about transfer pricing. These questions do not always lead to disputes, but the issue is raised more frequently than in the past. There can be tensions between the local case manager in charge of the case and the transfer pricing specialists; this process emerges from the recent restructuring of the IRS large business and international division and is still being worked through. US companies are in the crosshairs of foreign examiners, who see the publicity about Starbucks, Apple and other US companies and leap to the conclusion that all US based multinationals must be hiding money.
Q. In general, what advice would you give to companies on reviewing and amending their transfer pricing policies and structures?
Armitage: Ask yourself two questions; firstly, can you explain to a tax examiner how you construct your transfer prices? What transfer pricing method do you use? What company financial data do you use, and where do you get it? How do you project the results for the coming year when the price list will apply? And, how do you monitor performance and adjust the price list as needed? Second, can you explain the company’s value chain, and do the profits reside in the locations where you believe the value is created? These are tough questions, if we answer them honestly. But, honest answers will lead us to proper thinking and proper documentation.